Returned From Europe

I just returned from Europe, where I participated in two conferences sponsored by market-oriented think tanks. Some impressions below.

(Note: Tyler Cowen has some interesting things to say, blogging from Germany--Tyler and I failed to meet in Berlin, primarily because I did not have a cell phone. I should note that the German view of Germany's contribution to the European economy is quite a bit more pro-German than the view held by other Europeans.)

1. Here is one analysis of the plight of the European welfare state. Pointer from the Bruno Leoni Institute, the host of one of the conferences. It's less than 7 minutes, and it is really worth watching.

2. In the current crisis, Italy was able to raise the retirement age for women.

3. If Paul Krugman and Brad DeLong are having a hard time convincing American policy makers to expand our deficit, that is nothing compared to what they would experience in Europe. Many Europeans see themselves as fiscally tapped out. Also, they take pride in their overall savings (one Italian bragged that Italy's private saving was many times its national debt), and they think that the low savings rate in the U.S. makes it really inappropriate for the U.S. to continue to run large fiscal deficits. They think that international balance requires the U.S. to run smaller deficits, not larger ones. I am not saying that I endorse this view, but I think it is prevalent.

4. There is a growing awareness that a major factor in the Greek crisis is the large exposure of French and German banks to Greek debt. I think this is going to cause huge political problems for the Greek bailout. Already, you have people in Germany upset at bailout out Greeks. On top of that, you have many people in European countries outside of France and Germany who resent the power of France and Germany within Europe, and those people will not be happy with a bailout that largely serves the interest for French and German banks. A Polish economist complained of a double standard in which Greece was bailed out but other countries, like Hungary, were not.

5. With Europe tapped out fiscally, which way will the elites turn? Alberto Mingardi of the Bruno Leoni Institute worried that they will substitute regulation for government spending, trying to shift costs to the private sector. However, another scenario would be that governments recognize a need to increase economic growth, and we have a "Thatcher moment." Perhaps the outcome will differ across countries.

6. Along similar lines, what will be the effect of Eurocrats on the policies of individual states? Will they push for bad things, such as tax harmonization? Or will they give governments political cover to do good things, such as cutting back the welfare state and labor market rigidities?

7. According to an index of economic freedom for European countries, calculated by the Bruno Leoni Institute, the countries near the bottom include Italy, Greece, and Portugal. A lack of labor and business freedom is particularly notable. (I cannot find this on line in English. [UPDATE--it is here]

8. My idea of free markets is very alien to western European policy makers (it is fairly alien to U.S. policy makers, as well). However, some Eastern Europeans are more receptive. To Western Europeans, the Dutch health care system (a sort of Massachusetts plan for the whole country) is a forward-looking, market-oriented approach to health care. At the first conference, I felt obliged to disabuse the audience of that notion and instead present views based on Crisis of Abundance.

9. On financial reform, at least one European was happy with the U.S. reform plans. He thinks it includes some good ideas, such as improved resolution authority for troubled banks. He thinks that it includes bad things that will reduce the ability of U.S. banks to compete, and that will be good for Europe. However, another European disagreed on the latter point, saying that he thinks that Europeans will soon copy any bad regulations that the U.S. adopts. Sam Peltzman, Peter Wallison, and I all were skeptical of the value of improved resolution authority, because we do not think it will be used. We think that in practice large financial institutions will be bailed out when they get in trouble.

10. Peltzman believes strongly that what is needed for banks is deterrence. He showed a cartoon with a driver sitting in a car that has a giant spike sticking out from the steering wheel, suggesting that such a driver would have an incentive to be careful. What sort of spike in the wheel can we give to bank executives? In the past on this blog, I have suggested the threat of prison for executives of banks that become insolvent for non-natural causes. More realistic ideas are to reduce or eliminate the limited-liability protection for the owners of banks. Note that many people say that Wall Street's downfall was caused by the conversion of the largest firms to publicly traded companies from partnerships, which are inherently more risk-averse.

11. At the Bruno Leoni Institute conference, I contributed a couple of thoughts. I gave my pitch for the insider-outsider distinction as being more important than the left-right distinction. Insiders are policy makers and major financial executives. The left-right distinction does not explain the continuity in policy, represented by Obama's appointment of Geithner and reappointment of Bernanke. It does not explain the fact that in 2008 in Congress both support and opposition to TARP were bipartisan. It does not explain the fact that today in Congress both support and opposition to an audit of the Fed are bipartisan.

-- insiders think that the financial crisis and the European debt crisis were mostly liquidity crises, caused by excessive panic. Hence, European insiders blame "speculators" for their problems. Outsiders see solvency problems. Note that the question of "solvency" in the case of sovereign debt is largely political--at what point does the country not have the political will to tighten its belt sufficiently to repay its debt? I think we have passed that point with Greece.

--insiders think that the Lehman failure was the big mistake in the handling of the financial crisis. Outsiders think that bailing out Bear Stearns and not shutting down more banks were the larger mistakes.

--insiders think it would be dangerous to audit the Fed. Outsiders think it is necessary to audit the Fed.

etc.

12. The main difference is that insiders see this as a Keynesian moment, in which market breakdowns demonstrate a need for greater government involvement. I see this as a Hayekian moment, in which the dispersal and specialization of information has gotten so great that central technocratic control has become impossible.

13. On the role of technocrats in general, I think that the difference between heaven and hell is subtle. Heaven is where technocratic solutions must meet a market test. Hell is where they are imposed by the state. An example of the heavenly approach is the way issues of Internet governance are resolved. The solutions consist of recommendations of Internet Engineering Task Forces, which are adopted voluntarily by the developers of hardware and software.

I am really buying your insider/outsider narrative. I do not think it would take much work to show it as a variant or perhaps extension of "regulatory capture", as either a form of "old-boy network", or a cynical get-rich scheme for insiders, or as a desperate attempt for a self-appointed expert elite to be seen as doing something proactive.

All these things transcend left-right politics in that they are clubby and self-serving first.

they take pride in their overall savings (one Italian bragged that Italy's private saving was many times its national debt)

Ricardian equivalence at work, I suppose. But what happens if/when either the Italian government cannot service its debt, or Italian savers decide to sell government bonds and shift their savings abroad?

another scenario would be that governments recognize a need to increase economic growth, and we have a "Thatcher moment."

We are way beyond that: what we need is a Mart Laar moment. That is why I moved to Estonia. (Also I think that Thatcher made a couple of tragic mistakes that Britain is still paying for, not to mention the crisis of the early 1990s.)

According to an index of economic freedom for European countries [...] the countries near the bottom include Italy, Greece, and Portugal.

Does the index include all of New Europe?

To Western Europeans, the Dutch health care system (a sort of Massachusetts plan for the whole country) is a forward-looking, market-oriented approach to health care.

It's market-oriented in the sense that there is no state monopoly of health care. (Also, health costs are lower in the Netherlands than in Massachusetts -- at least for now.)

Peltzman believes strongly that what is needed for banks is deterrence.

I'm not sure what you're asking about in regards to the Italian government being unable to service its debt, most Italians - I can say this because I am one - do not believe that the government can service its debt. We're more surprised that people keep lending to our government than we would be if our government were declared to be insolvent.

As for bonds... That's not how we save in Italy.

Honestly, I'm not as grim about our economy as some are. True, the government is doing poorly, but that's the government and Italians have long been separated from that. Our people are doing fine, a good deal of our income goes unreported and we pay little in taxes, our mortgage debts are modest, and we're not leveraged highly at all.

It might actually be good for us if the government does go belly up, because it is never going to reform.

Niccolo: thank you for your reply. I think that you are too pessimistic about the chances of an Italian debt default, but also too optimistic about what that would mean for the Italian people: don't you rely almost entirely on state pensions?

It might actually be good for us if the government does go belly up, because it is never going to reform.

Maybe you are right, but I'd think that a leader who combines the economic sense of Amato or Prodi with the Machiavellian skills of Berlusconi could do it.

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